FLASHPOINT: SECURE 2.0 Permits Employer Roth Contributions

By Alison J. Cohen and Ilene H. Ferenczy, Esqs.

As many 401(k) plans have a January 1 plan year beginning, now is the time of the year that plan sponsors are considering whether to make changes to the plan, including adding one or more of the newly available features created under the SECURE 2.0 Act of 2022 (“SECURE 2.0”). One of these new features that can be made available to help plan participants save for retirement is the ability to allow them to elect to have Employer Contributions made as Roth amounts, rather than on the historical pre-tax basis.

SECURE 2.0 Section 604 allowed for this additional feature to be added to most retirement plans, including 401(k), 403(b), and governmental 457(b) plans. (But see the section below regarding other qualified plans.) The Internal Revenue Service (“IRS”) issued guidance in Notice 2024-2 at the very end of 2023 on various pieces of SECURE 2.0, including the Employer Roth Contribution election process.  For those of us who can’t remember what happened last week, this is a refresher on the details on how plan sponsors can initiate this provision.

I Love Roth!  How Do I Do That?

An employee’s election to have an Employer Contribution treated as a Roth amount must be irrevocable and made before the contribution is allocated to the participant’s account. Participants must be permitted to make or change the election to have Employer Contributions treated as Roth at least once during the plan year. Note that this doesn’t mean that if a plan sponsor funds its matching contribution on a per payroll basis it has to permit participants to change their election on each payroll period. It just has to permit the election once per plan year, and that election can apply only to Employer Contributions allocated after the election is made.

Example: Hans, an employee at the Nakatomi Corporation, decides at the beginning of June 2025 that he would like matching Employer Contributions to be made to his account as Roth amounts.  Nakatomi has already contributed $1,000 in matching contributions for him, and they were allocated to his account on a per payroll basis. If Hans continues to make salary deferral contributions at the same rate through the end of the year, he will receive additional matching contributions through the end of the year equal to $1,400. If he makes the election now, he will have a total of $1,000 of pre-tax and $1,400 of Roth matching contributions for 2025. (He cannot make an election in June in relation to the matching contributions that are already in his account.)

The Employer Contribution that was treated as a Roth amount will be taxable to the participant in the year in which the contribution is allocated. For example, the Nakatomi Corporation funds its 2024 profit sharing contribution in 2025. If Hans elects to have this contribution treated as Roth, he will have to declare it as income for 2025. (Note that the year of the company’s deduction of the contribution may be different than the year in which it is considered income to the participant. In the above situation, it is likely that Nakatomi will take a deduction for the contribution for calendar year 2024, but Hans will not claim it as income until 2025.)

Just like Roth 401(k) funds, any Employer Contribution that is elected to be Roth must be accounted for separately from non-Roth amounts.

Restrictions on the Election

The plan sponsor may choose to permit separate Roth elections for each money type. While it would be unusual that a plan wouldn’t permit the employee to make Roth 401(k) deferrals but then permit Roth Employer Contributions, to do so is allowable.  Conversely, a plan could permit Roth 401(k) deferrals, but not permit Roth Employer Contributions.

Participants may elect the Roth Employer Contribution only if the particular money source to which the election applies is fully vested at the time that the contribution is allocated. This restriction can be applied separately to each money source that may be funded to the plan. For example, if a participant is 100% vested in matching contributions, but only 60% vested in the nonelective/profit sharing source, then the participant may make a Roth election only for the matching contribution. This restriction is not considered to be discriminatory under Internal Revenue Code (the “Code”) Section 401(a)(4) even though not all participants may be able to make the Roth election due to vesting.

How are Roth Employer Contributions Treated for Income Purposes?

Roth Employer Contributions are not included in wages, as defined in Code Section 3401(a). Therefore, the plan sponsor won’t be reporting the Roth Employer Contribution anywhere on the participant’s Form W-2. Nonetheless, a participant making this election would be wise to increase their per payroll income tax withholdings to help with the tax liability that will occur at year end, but this is not required.

Along this same vein, Roth Employer Contributions are not included in, or subject to, FICA and FUTA taxation. FICA is the Federal Insurance Contribution Act, which is the tax that goes towards funding Social Security and Medicare benefits. FUTA is the Federal Unemployment Tax Act, which is the tax that goes towards providing unemployment benefits.

The income from the Roth Employer Contributions is shown on a Form 1099-R for the year in which the Roth Employer Contribution is allocated to participant accounts. These amounts are reported on Form 1099-R in Boxes 1 and 2a, with code G reported in Box 7. Typically, it will be the plan’s recordkeeper/custodian that will issue Form 1099-R. However, if the plan sponsor uses a less traditional form of recordkeeping, such as individual self-directed brokerage accounts (“SDBA”), it should talk to its SDBA vendor to see who is responsible for issuing Form 1099-R.

Example:  John McClane is also an employee of Nakatomi Corporation.  He is fully vested in all Employer Contributions being made to the 401(k) plan. He elects at the beginning of 2025 to have all possible Employer Contributions contributed as Roth amounts. During 2025, John has $75,000 of regular salary from Nakatomi, and the company contributes $3,000 to his account in matching contributions. After the end of the year, Nakatomi contributes a 10% profit-sharing contribution on behalf of all its employees.  John’s share of that contribution, allocated in 2026, is $7,500.

John’s Form W-2 will show his $75,000 salary (minus any 401(k) salary deferrals) as taxable income, and that is the amount that will be the basis for his payroll tax withholding. The full $75,000 will be subject to FICA taxation throughout the year.

A 2025 Form 1099-R for $3,000 will be issued in relation to the matching contributions. John’s taxable income will be increased for 2025 by that $3,000. A 2026 Form 1099-R will be issued in the amount of $7,500, reflecting the profit-sharing allocation made to his account during 2026.

If John were only partially vested in his profit-sharing account, none of the profit-sharing contribution could be elected to be treated as Roth.

Are There Any Unaddressed Concerns Regarding Balance Forward Plans?

We’ve assumed so far that the contributions are credited to participant accounts by the recordkeeper as soon as they are received. But what if the plan is not participant-directed and investments are pooled? When are participants taxed in that situation?

Example:  Holly Gennaro is a doctor who owns her own small medical practice that sponsors a 401(k) plan. She makes all contributions to one account and the account is invested as recommended by her financial advisor. When the year’s administration is done by Holly’s TPA, the contributions, forfeitures, and earnings are all allocated to the participants’ accounts, usually in the middle of the calendar year following the plan year. When do the participants recognize income from the matching and profit-sharing contributions?

As all contributions are allocated during the following year, all taxation of Roth Employer Contributions should also be made in the following year, when the amounts are allocated.

This rule, however, raises an interesting question: what if Holly doesn’t have a TPA and no actual allocations of contributions for 2025 are made in her plan until 2027, when she finally hires someone?  Are amounts taxed when allocable under Plan terms, or when someone commits the allocation to “paper” (or spreadsheet, as appropriate)? When are Forms 1099-R due? Similarly, can the owner of the plan sponsor manipulate tax timing by simply ordering their TPA to allocate amounts in the year that is most advantageous to the sponsor?

What About Non-401(k) Qualified Plans?

The IRS guidance does not appear to limit the ability to elect Roth treatment of Employer Contributions to plans that may permit salary deferrals. In particular, the general rule of Code Section 402A(a) that permits Roth Employer Contributions applies to “an applicable retirement plan [that] includes a qualified Roth contribution program.” An applicable retirement plan is defined in Section 402A(f)(1) to include any “employees’ trust described in section 401(a) which is exempt from tax under section 501(a).” A qualified Roth contribution program is “a program under which an employee may elect to make, or to have made on the employee’s behalf, designated Roth contributions of all or a portion of elective deferrals the employee is otherwise eligible to make, or of matching contributions or nonelective contributions which may otherwise be made on the employee’s behalf, under the applicable retirement plan.” [Emphasis added.]

Therefore, it appears that any profit-sharing plan or even money purchase pension plan could be amended to permit Roth treatment of the Employer Contributions thereunder. However, as the guidance has not been clear on this point, it might be best to wait for confirmation of this from the IRS.

Remember:  In-Plan Roth Rollovers May Also Be Available

Even if the employer does not want to institute Roth Employer Contributions, the plan may nonetheless permit the employee to convert a pre-tax account to a Roth account through an in-plan Roth Rollover.  Unlike an election for Roth Employer Contributions, however, a separate employee election must be made for each such in-plan Roth Rollover.

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If you have any questions, please call us.  After all, we are your ERISA solution!

Having problems keeping all the SECURE 2.0 provisions straight for 2025?  For your reference, we have included a link to an outline written by Ilene Ferenczy for a speech she gave in November. The outline gives you a good summary of the SECURE 2.0 provisions that are effective in 2024 and 2025.

Also, be sure to sign up to see Ilene at the NIPA Business Managers Conference in Scottsdale on January 15-17, as well as Derrin and Ilene at the FIS Advanced Pension Conference, January 29-31.